Non-Fungible Tokens: What They Are and How They Function

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Non-fungible tokens (NFTs) are blockchain-based digital tokens that represent real-world objects, such as art, in-game items, music, and even real estate. Thus, NFTs are tokenized versions of assets authenticated through blockchain technology and purchased using cryptocurrencies. They are unique and can't be exchanged like-for-like.

To put it simply, all fiat currencies are fungible — one dollar is equal to another dollar. One bitcoin (BTC) is also directly interchangeable with another. NFTs are not interchangeable with each other, as the underlying asset is unique.

A classical showcase of what an NFT is could be an artwork. For example, Raphael's “Sistine Madonna” is in no way equivalent to Da Vinci's “La Gioconda.” In fact, even owning regular items often makes it unique, e.g. a glove worn by Theodore Roosevelt or Lady Gaga's t-shirt.

An NFT's functions are quite similar to a certificate of ownership for digital or physical assets that can be purchased and sold.

"[NFTs] have similar property rights that you would associate with physical things," said Devin Finzer, the founder and CEO of the marketplace OpenSea.

NFT use cases

Today, the most frequent application of NFTs can be seen in the following sectors:

  • Digital art
  • Video games
  • Collecting
  • Virtual worlds

Using NFTs in digital art allows creators to record the authorship or ownership of a particular work and subsequently receive royalties, which is recorded in a smart contract.

Prominent examples include Mike Winkelmann, or Beeple, a graphic designer who sold his digital artwork dubbed “Everydays: The First 5000 Days” as an NFT for over $69 million via the Nifty Gateway marketplace.

The market offers a slew of other NFT marketplaces, with Rarible, SuperRare, and KnownOrigin being the most popular of them.

Tokenization of in-game items makes it possible to own them and transfer rights to a new owner, without setting up a complex process for their sale. In addition, a digital item can be programmed to develop and enhance its properties. Thus, users can both use those items in games and trade them as crypto collectibles.

NFT games also allow users to earn crypto while playing. At this point, the NFT games that are gaining more traction are Axie Infinity, Sorare, CryptoKitties, Gods Unchained, and Decentraland.

NFTs are the right step towards digitization of the collecting industry, as it’s been actively moving from physical objects to virtual ones. Through NFTs, it’s possible to either create a one-of-a-kind virtual asset or tie it to a physical object, such as books, basketball cards, etc.

NBA Top Shot, a platform jointly developed by Dapper Labs and the basketball league, is an example of digital collectibles. On the platform, users can buy and sell short clips showing match highlights from top basketball players.

Virtual worlds seem to be the most complex from the technical point of view, since the tokenization of such worlds may imply anything, from land and buildings to any items ranging from clothing or virtual cars.

In virtual worlds, it’s possible to buy a building, which subsequently can be used as a gallery exhibiting digital artworks. All the objects in virtual words are unique, thanks to non-fungible tokens.

The Sandbox and Terra Virtua are popular blockchain-based virtual worlds, or digital collectibles platforms.

Technical aspects of creating an NFT

Although many blockchains can implement their own versions of NFTs, the Ethereum (ETH) blockchain — that powers cryptocurrency ether — enjoys worldwide popularity, when it comes to creating NFTs, due to its ability to execute smart contracts.

Basically, non-fungible tokens are smart contracts proving that a certain digital piece is the original, while all the others are its copies. Once a user creates an NFT, it contains their artwork and a contract on a blockchain that proves the user created the artwork and that it’s the original.

Thus, in NFTs, each piece of content is linked to a single token stored in a smart contract that registers all the transactions related to the item. Since it's recorded on the blockchain, it’s possible to check the entire transaction history of the piece.

Many wonder where NFTs are actually stored. Well, an NFT is a record stored on the blockchain, e.g. Ethereum. Since storing a large amount of data — including artworks and other items — on the blockchain is very expensive, often it only has the address of where the NFT sits somewhere else on the internet.

It turns out, an NFT just informs the user where the actual content lives at the time it was minted. This way, the token and the content live separately and, in fact, creators can’t be sure about how reliable the storage site is.

The content may be altered or deliberately deleted, making it difficult to prove that it is exactly what is associated with your NFT.

To resolve this issue, leading industry players are working on the maximal decentralization of media storage. Today, the market offers the following options:

On-chain storage lets users store media and metadata in the blockchain itself, which makes the stored data available to all parties in the system. On-chain NFTs are reportedly completely secure, however harder to make.

Partial on-chain storage (or partially centralized NFTs) allows users to store only key data of their content in the blockchain, which can help restore the media if needed.

InterPlanetary FileSystem (IPFS) storage. This kind of file system is distributed across a large number of computers, which creates a unique hash code at the time a user uploads their media to IPFS. That hash code is recorded in the smart contract of the NFT.
To conclude, tokenization provides assets with additional properties, such as ownership and inalienability, thanks to decentralization, liquidity, versatility, and programmability.